Axios AM Deep Dive

The system for setting drug prices in the U.S. is a labyrinth. It can be enormously frustrating for patients — and enormously rewarding for the drug companies, pharmacies, doctors, hospitals and assorted middlemen that profit along the way.

The big picture: The cost of a drug depends on many factors: whether it’s a brand-name product or a generic; secretive industry negotiations; even the way the drug is administered. Each patient's price may be different.

• "There’s so much variability, and that’s where all the money is being made," said Eric Pachman, a former pharmacy manager who co-founded the drug data firm 46brooklyn Research.

How it works: Using publicly available data and common industry assumptions, Pachman built out a rough, simplified sketch of how money changes hands for a "typical" generic drug.

• This drug would cost about $3 to make and would sell for about $15.
• So, what happens to the other $12? It’s split among the manufacturer (about $3), the pharmacy ($1.50), a wholesaler ($2), and, finally, the largest share goes to the company that manages your insurance plan’s drug benefits ($5.50).

The numbers would look a lot different for the more expensive brand-name products that drive most of America’s drug spending. Those are the ones you’ve probably heard of, like the Epi-Pen or Humira, the world’s top-selling drug.

• They often start with high sticker prices. Humira’s is more than $58,000 per year, according to Elsevier's Gold Standard Drug Database.
• Different insurance plans negotiate different discounts off that list price. All of them are kept secret. The negotiators also keep some of the savings for themselves. That number, too, is a secret.
• There’s a whole different pricing system for drugs administered by a doctor, and yet another system for certain hospitals.

The bottom line: It’s a free-for-all behind the scenes.

• "The system is vulnerable, and you can abuse it," said Mick Kolassa, a retired consultant who helped drug companies with pricing practices for almost 40 years.

Drug prices are a big deal politically because they’re a big deal personally. Time after time, the issue is thrust back into the spotlight by virtue of giant price increases on drugs that aren’t new or innovative, but are still life-savers for millions of people.

• It happened when "pharma bro" Martin Shkreli bought Daraprim, a drug to treat AIDS, and raised the price by 5,000%.
• It happened when Mylan raised the price of the Epi-Pen by about 500% over 6 years.
• It has been happening for years with insulin, where prices keep creeping higher, adding up to increases of more than 200% for some products.

The trade-off between costs and benefits still matters for new drugs, too. New leading-edge treatments, like immunotherapy for cancer, offer lifesaving promise that almost any family would want but few can afford.

• The debate is more complicated with new drugs, though, because we know their development costs are still on the books.
• That’s why big price hikes on old drugs, that people have depended on for decades, spark particularly fierce outrage.

"It's really one of my greatest fears," Clayton McCook, who has to meet a $3,000 annual deductible to cover medication and supplies for his diabetic 10-year-old daughter, recently told Axios. "If insulin is $300 a vial now, what's it going to look like in 20 years when she's on her own?"

A version of that scenario is already a reality for Nicole Smith-Holt. She lost her son Alec, 26, to diabetic ketoacidosis shortly after he began rationing insulin. Alec died less than a month after he was no longer eligible for his mother’s insurance plan. He was facing costs of $1,300 per month.

Go deeper: The outrage over insulin prices

Over the past few years, there’s been a growing push from researchers to figure out which drugs are worth their price tags.

Other countries, like the U.K., attempt to answer that question with governmental bodies of experts who determine how much value certain drugs provide, compared to their price. The U.S. doesn’t have such an organization, in part because the pharmaceutical industry hates the idea.

Where it stands: The independent Institute for Clinical and Economic Review, or ICER, has tried to fill that void here.

• ICER said the expensive new cancer therapies known as CAR-T, which can cost as much as $500,000, are for the most part reasonably priced.
• There’s a similar debate over new hepatitis C drugs, which have list prices near $100,000 per treatment and are essentially a cure, preventing expensive hospitalizations down the line.
• ICER already works with the Department of Veterans Affairs to help determine which drugs it should and shouldn’t cover.

Yes, but: "The fact that we can spread a price across thousands or millions of people does not justify a given price," Walid Gellad, a medical and pharmaceutical professor at the University of Pittsburgh, recently mused.

Prescription drugs are the political center of the health care debate, but we actually spend a lot more on hospital care and doctors’ visits.

By the numbers: In 2016, the U.S. spent a little less than $330 billion on the kind of drugs you pick up at a pharmacy, according to federal data. That's about 10% of all health care spending.

• Add in drugs that are administered by a doctor, and various estimates put the total closer to $450-475 billion, or 10-15% of health care spending.

But here's why drugs still get so much attention:

• A few products can drive big spikes. Drug spending isn't growing too fast right now, but it leapt 12% in 2014 — because 2014 was the year high-priced hepatitis C treatments came onto the market.
• The future is trending toward more expensive drugs. Highly complex "specialty" drugs (like those hepatitis treatments) make up less than 2% of all prescriptions, but are rapidly closing in on 50% of all spending.
• Insurance deductibles keep getting bigger, which means people have to pay more of their own costs out of pocket. And while you may not have been to the hospital in a long time, millions of Americans use prescription drugs every day.

Even though we spend a lot more on hospitals and doctors, pharmaceutical companies keep a lot more of the money. In the third quarter of this year, drug companies accounted for just 23% of the industry’s revenue but controlled 63% of its profits.

Americans don’t have much confidence in President Trump’s pledge to bring down drug prices, according to our latest Axios/SurveyMonkey poll.

• Overall, 61% of respondents said they’re not confident Trump will be able to follow through on his promise of cheaper drugs, while 37% said they’re very confident or somewhat confident that he’ll deliver.
• Unsurprisingly, the survey found a stark partisan divide: 80% of Republicans said they’re at least somewhat confident Trump will be able to reduce drug prices, while 93% of Democrats are confident he won’t.
• Independents agree with Democrats.

Because the system is so complex, policymakers have a lot of options to choose from if they want to bring down drug costs. But some of those avenues are more meaningful than others. There are three broad categories of ideas:

1. Move the money around. These proposals could reduce what patients pay for drugs, but not necessarily what the health care system as a whole pays.

• They would mostly rearrange existing discounts within the supply chain — like making pharmacy benefit managers, who negotiate discounts on behalf of insurers and employers, pass more of those savings on to patients at the pharmacy counter.

2. Increase competition. The Food and Drug Administration has been approving generic drugs at a breakneck pace and has prioritized areas that don’t have much competition (the first generic Epi-Pen is a prime example).

• Critics say pharmaceutical companies are unfairly blocking generic competitors by manipulating the patent process. There’s an argument, even among some conservatives, that government may need to step in to enforce more market competition.

3. Reduce the prices. The marquee policy here would be to give Medicare more power to negotiate — or simply to dictate — what it will pay for drugs.

• Democrats say that would not only lower costs for seniors and Medicare, but for everyone, because private insurance wouldn’t pay much more than Medicare does. Drug companies say it would dry up innovation and research.

Go deeper: How to lower drug prices

Pharma was happy when President Trump first released his blueprint to lower drug prices, which mainly targeted industry middlemen, not drugmakers, and relied on private-sector competition, not direct government intervention.

But things have taken a turn.

• First, the administration proposed requiring pharmaceutical companies to include drugs’ sticker prices in their TV ads. The industry says it’s a violation of the First Amendment, and there’s a real debate over whether that information would be very useful.
• Next came a plan to base Medicare’s payments for certain drugs on the prices European countries pay — in other words, to piggyback off of single-payer or highly socialized health care systems. That’s a pretty big plot twist for a Republican administration.

Yes, but: Industry will have ample opportunities to kill both of these proposals, and both could end up having modest impacts even if they do end up happening.

The bottom line: Divided government probably won’t produce a grand bargain on drug pricing. The industry is still very powerful, and Congress' ideological differences are still real.

• But pharma nevertheless will be on worse footing in January than it is today, and it’s on worse footing today than it was a year ago.
• It’s increasingly at odds with what seemed like a friendly administration, and it’s losing some of the allies on Capitol Hill who could help fight Trump’s most dramatic plans.

The pharmaceutical industry has spent enormously on lobbying in the age of Trump, Axios’ Caitlin Owens notes.

• In 2017 alone, PhRMA, the industry’s leading trade group, spent $25.8 million, according to the Center for Responsive Politics. So far in 2018, it's spent $21.8 million. That doesn’t include individual companies’ lobbying efforts.
• The industry is seeing "some of the most exciting innovation we’ve ever seen, and we need to make sure we have a health care system that continues to support those types of treatments," Robert Zirkelbach, an executive vice president at PhRMA, told Caitlin.

Most of that spending is defensive. Pharma isn’t trying to get new things passed; it’s trying to block or undo policies it doesn’t like. And that's not as easy as it used to be.

• The industry is still pushing Congress to reverse a relatively minor Medicare change that could cost the industry billions. At the same time, it's trying to scale back a bill that would provide generics with easier access to the samples they need to make their products.

Industry was freaked out not just by Trump's plan to import European drug prices, but by congressional Republicans' silence about a proposal they once abhorred.

• "To some extent, the lobbying effort has looked like how you would treat a traditional Republican administration and a Republican-controlled Congress. And that's not at all what we have. We have something that looks wildly different than that," a pharmaceutical lobbyist told Axios.

Go deeper: Trump pits Republicans against their donors

Generic erythromycin, an antibiotic, saw price hikes every year from 2010 to 2018, ultimately ending up more than 50 times more expensive than it started. It's not alone. Axios' Felix Salmon reports that, at any given time, roughly 200 drugs fulfill four criteria:

• They're available in generic form.
• They're on the World Health Organization's list of essential medicines.
• Their price has increased by more than 50%, in a way underlying market conditions can't justify.
• They have suffered shortages that have harmed patients.

The market-based solution to this problem would be for a new company to start manufacturing those drugs. Often, however, there's a market failure, and the drugs remain hard to find or exorbitantly expensive for years.

Enter Civica Rx, a nonprofit that intends to solve the problem by not making any money at all.

• Civica is a consortium of seven hospital groups and three philanthropies. They've each already donated $1 million to the nonprofit, and have pledged to make at least $9 million more in loans, if necessary. That's total funding of $100 million.
• Its hospital members can enter into a multi-year binding contract to buy large quantities of any given drug. That gives Civica, as a drug manufacturer, a lot of certainty when it comes to future demand.
• Civica then contracts with its own vendors, locking in drug supplies for many years.

"Most generic manufacturers will never even run into us," says Dan Liljenquist, Civica's chairman.

• Civica is not a danger to the generic drug industry; it will operate only as a manufacturer of last resort in the rare cases where that industry has experienced market failure.
• "We don’t need to fix the whole market," Liljenquist tells Axios, "because the whole market’s not broken."

Expect to see Civica's first drugs hitting the market as early as the second quarter of 2019.

We keep mentioning “middlemen” as part of the complex, expensive drug supply chain. They’re actually called pharmacy benefit managers, or PBMs, and their role in the system is both incredibly important and incredibly opaque.

How it works: PBMs are hired by an insurance company or a self-insured employer.

• Their job is to take care of the prescription-drug coverage for that insurance plan, which includes negotiating with drug companies for discounted prices.
• PBMs are a big part of the reason overall drug spending has held pretty steady lately, even as sticker prices rise.

The intrigue: PBMs do this through a complex system of rebates, in which they hang onto a percentage of the discounts they negotiate.

• PBMs' primary business model is drawing increasing scrutiny, as critics suggest it gives them a perverse incentive to play along with higher drug prices. Ohio's Medicaid program, for example, recently forced its PBMs to move to a new system of fixed fees.

Axios was able to bring some light into the darkness of the PBM world earlier this year, after we obtained a copy of a contract template used by Express Scripts, the country’s biggest PBM.

• That document helped illuminate the many subtle ways these companies are able to tilt the playing field in their favor as they work with employers and insurance plans.

Read the full investigation here to go deeper on a critical part of the health care industry.